Managing Risk in Your Commercial Real Estate Portfolio

Portfolio Management

The Fed made headlines in February with its 8th interest rate hike in the last year. Consumers and businesses are in a tight squeeze, trying to withstand continued inflation while adjusting to higher interest rates. Not only does the current economic climate impact small business and consumer lending, it can also have a significant impact on commercial loan portfolios.

To weather the storm, community financial institutions will need to re-evaluate their approach to portfolio monitoring within their commercial loan portfolios. Here’s what lenders need to know to weather the storm.

Economic pressure is trickling up to CRE lenders

Small businesses already feel the impacts of the latest rate hike, as access to credit has become more expensive than it has in years. In fact, 40% of small business owners say they are very concerned about the effect rising rates will have on their business. Meanwhile, inflation is putting added pressure on small businesses, with half of small business owners reporting that inflation is the biggest challenge facing their business right now, according to the U.S. Chamber of Commerce. The chamber also reported that in order to cope with inflation, 7 in 10 small businesses raised prices in response to inflationary pressures.

Consumers are feeling similar pressure. Record-high prices for everyday goods, combined with rising interest rates are posing financial challenges, especially for consumers with existing debt. As a result, growth in consumer spending has slowed, according to transaction data from Visa.

This challenging economy, along with the ripple effects of the pandemic have serious implications for commercial real estate lending.

Post-pandemic, many small-to-medium-sized businesses (SMBs) are reconsidering their use of brick-and-mortar locations. Some are renegotiating rents, while others are downsizing or going fully remote. Office space just doesn’t hold the same value anymore. 

The SMBs that do maintain their physical storefront or office space are seeing inflation eat into their revenues, meaning they run the risk of being unable to pay rent. If SMBs are unable to pay rent each month, this impacts the property owner’s ability to make their monthly loan payments.

Consider an example of a mom-and-pop ice cream shop that operates from a strip mall location. The shop will need to generate enough revenues to cover the cost of their rent. If they can’t, they’ll likely go out of business and leave behind a costly vacancy for the commercial property owner. According to Equifax, the average cost of losing a tenant costs more than $66 per square foot. Given the cost of a vacancy, the property owner may then face difficulty making monthly loan payments in-full, on time.

All of these factors point back to why community financial institutions need solid data and portfolio monitoring practices in place to mitigate delinquencies in their commercial loan portfolios.

CRE lenders need better data to manage risk exposure

CRE lenders know that actionable data sets their portfolio up for success. The right data gives lenders the information they need to structure deals accurately and mitigate the risk of delinquencies. However, it can be challenging to collect all of the necessary financial data on not just the commercial borrower, but also for the businesses and tenants associated with the commercial property. This can be an incredibly cumbersome process that requires time, staff and additional resources, which smaller community financial institutions may not have.

Community banks and credit unions represent 30% of the industry’s commercial real estate loans, according to FDIC data. These institutions need more reliable and easier access to forward-looking data on commercial properties. The right data, which is often external data, can offer financial institutions additional context about local markets, tenant risk profiles and more to support more accurate, data-driven credit decisions.

The good news is that a robust commercial loan origination solution, such as Baker Hill NextGenÒ that integrates detailed information on a commercial property’s tenant base ensures financial institutions have a clear view of risk to make the smartest lending decisions possible.

Going a step further, community financial institutions can continuously manage risk within commercial loan portfolios with automated portfolio monitoring. By analyzing data points like credit bureau data, loan, deposit, and collateral data, and financial statement data on a consistent basis, banks and credit unions can more easily pinpoint problem loans before a delinquency occurs. For example, Baker Hill NextGenÒ Portfolio Monitoring relies on data to flag potentially troubled accounts, such as a commercial property owner who has experienced a decline in monthly deposits, but hasn’t yet missed a monthly loan payment. This may indicate the property owner has tenants who are struggling financially or may be late on payments. With this intel, the lender can step in sooner before it’s too late and help the borrower stay on track.   

While rising interest rates and inflation are nothing new, the post-pandemic realities of hybrid and remote work policies, along with ongoing supply chain challenges are additional complexities that make this a unique economic environment for CRE lenders to navigate. However, with the right data and the right portfolio monitoring tools, community banks and credit unions can grow their commercial loan portfolios with confidence.